The Simply Good Foods Company
Q2 2018 Earnings Call Transcript

Published: 10 Apr 2018

[Operator:]

Greetings and welcome to the Simply Good Foods Company Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require Operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to Mark Pogharian. Thank you, you may begin.

[Mark Pogharian:]

Thank you, Sherri. Good morning. I am pleased to welcome you to The Simply Good Foods earnings call for the second quarter ended February 24, 2018. Joe Scalzo, President and Chief Executive Officer, and Todd Cunfer, Chief Financial Officer will provide you with an overview of financial results, which will then be followed by a Q&A session for sell side analysts. The Company issued its earnings press release this morning at approximately 7

[Joe Scalzo:]

Thank you, Mark. Good morning and thank everyone for joining us. Today I’ll recap our second quarter highlights and I’ll provide an update of our business, then Todd will discuss a summary of our second quarter and year-to-date financial results, and after that we’ll open the call to your questions. Before I do that, let me welcome Mark Pogharian to our team. Mark joined us just last week as VP, Investor Relations, Treasury and Business Development. He brings significant experience in these areas and broader finance after nearly 25 years in the consumer packaged goods industry. I know he’ll be a great addition to our team and I look forward to the contributions he’ll bring to our business and to working with him. Welcome, Mark. Our second quarter continued the strong business momentum we experienced in the first quarter. For the second quarter, net sales grew 6.9% year-over-year with adjusted EBITDA up 3.9%. This growth continues to underscore the strength and the resilience of our core business and the powerful nutritious snacking macro tailwinds of convenience, meal replacement, and low carb, low sugar protein rich products. We generated U.S. POS growth of 5.1% in the first 26 weeks of our fiscal year as a result of continued growth in our core U.S. nutritional snacking business and strategic marketing efforts to target a broader consumer audience. As expected, our measured channel POS growth continued to be solid in the second quarter and increased 4.7%, resulting in year-to-date growth of 5.1%. This excludes our ecommerce business, which continues to accelerate, and while still early, our POS momentum in the first month of the third quarter is accelerating. The most encouraging part of our strong retail performance is that it’s coming entirely from base velocity growth which more than offset planned distribution losses. We believe our strong velocities are driven by a number of factors

[Todd Cunfer:]

Thank you, Joe, and good morning everyone. Let me start with two points as it relates to the numbers you see on the slides that follow. First, for comparative purposes we will review unaudited financial statements for the quarter and year-to-date ended February 24, 2018 and pro forma financial statements for the quarter and year-to-date ended February 25, 2017, which presents our results as if the business combination had occurred as of August 28, 2016, including amortization expense based on the fair value of assets after the purchase, and interest expense based on the new capital structure. We believe this discussion provides helpful information on the performance of the business during this period. All financial measures discussed today will be on a pro forma combined basis. Second, we also evaluate our performance on an adjusted EBITDA basis based on our asset-light strong cash flow model. We have included a detailed reconciliation from GAAP net income to adjusted EBITDA in today’s press release. We believe this measure is a key indicator of the true underlying performance of the business. The second quarter results are as follows. Net sales were up 6.9% to $109 million driven by organic core growth of 5.8%. The acquisition of Wellness Foods Simply Protein brand contributed 1.1% to sales growth in the quarter, and recall the year ago period only captured one month of Wellness Foods sales. Gross profit increased 7.9% to $50.3 million with gross margin up 50 basis points to 46%, driven by lower supply chain costs. Net income increased $35 million to $41.4 million due to higher gross profit and two impacts from the Tax Reform Act, specifically a $29 million gain on the revaluation or re-measurement of deferred tax liabilities and a $4.7 million gain in fair value of our TRA, or Tax Receivable Agreement. Due to the Tax Reform Act, our effective tax rate in the second quarter was about 15%, reflecting a true-up of our year-to-date tax rate to about 28%. Note that this excludes the aforementioned $29 million gain. Additionally in the second quarter, we incurred slightly higher distribution and customer service costs, $1.9 million in transaction costs as a result of our secondary offering in February and M&A due diligence expenses, and as a reminder our legacy shareholder exercised their right to sell their shares in the second quarter. Also, we had higher customer-specific selling expense to engage online customers as well as greater levels of in-store activity, and as we stated last quarter, we’re incurring higher G&A expenses as a result of public company costs and the acquisition of Wellness Foods. Lastly, adjusted EBITDA increased 3.9% to $18.8 million versus $18.1 million in the year ago period. Year-to-date results show similar growth as well. Net sales increased 6.8% to $215.9 million driven by organic core growth of 4.9% and the acquisition of Simply Protein, which added 1.9% to net sales. Gross profit increased 8.1% to $103 million in the first half with gross margin up 60 basis points to 47.7% due to lower supply chain costs and favorable product mix. Net income increased $36.1 million to $51.6 million due to the previously mentioned $29 million gain from the deferred tax liability re-measurement and the $4.7 million gain on the TRA, in addition to the gross profit improvement. This was partially offset by slightly higher distribution costs, the $1.9 million of previously discussed transaction costs, a 7.3% increase in selling expense which includes efforts to increase in-store activity, and a 10.8% increase in G&A as a result of Wellness Foods and public company costs. The Company continues to benefit from very attractive cash flow characteristics underpinned by our asset-light business model, which enables strong cash flow generation. Capital expenditures for the first half of 2018 were approximately $0.9 million driven by our investment in our new website and digital media applications. We estimate full-year capex of approximately $1.8 million. As we discussed in January, we will see a benefit from the Tax Reform Act signed into law on December 22. As I stated earlier, the benefits to Simply Good Foods are both one-time and ongoing in nature. For fiscal year 2018, we estimate a blended adjusted effective rate of 28%, which is lower than our previous guidance of 31 to 32% due to the one-time booked gain on the TRA, which is not taxable. While preliminary, we anticipate our adjusted tax rate in fiscal 2019 will be in the 26 to 28% range. The decline of our effective tax rate in fiscal 2018 is about a $4 million benefit to cash flow and net income, and given our solid cash position and balance sheet, we have financial flexibility to reinvest a portion of this benefit that results in building our business and long-term shareholder value. Specifically in the second half of fiscal ’18, we will reinvest a portion of the tax savings in the form of brand building capabilities and people. This will include incremental strategic investments in marketing and brand building initiatives to drive further top line growth and carry momentum into fiscal 2019, and investments to enhance organizational capabilities in key functions, including preparation for compliance requirements in the future. While we are not required to be SOX compliant in fiscal 2018 given our status under the 2011 Jobs Act, we have decided to accelerate our preparedness as we believe it will help us as we look to integrate and scale future M&A, and in appreciation for their hard work during the past year, an employee bonus of $1,000 in cash for all employees below the director level. Given this, we now expect fiscal 2018 adjusted EBITDA to increase at a rate slightly lower than net sales growth, which we still target at 4 to 6%. Moving onto the balance sheet and cash flows, as of February 24, 2018 the Company had cash of $79 million and a $200 million term loan outstanding, resulting in a pro forma net debt to adjusted EBITDA ratio of 1.6 times. The Company also has a $75 million revolving line of credit available with no borrowings outstanding as of February 24, 2018. We also successfully re-priced our term loan on March 16 at LIBOR plus 350 basis points, a reduction of 50 basis points from the previous spread. One-time costs associated with are more than offset by interest savings in the first five months. That concludes my financial overview. I will now turn the call back to Joe for brief closing remarks.

[Joe Scalzo:]

Thanks Todd. In summary, we remain confident in the growth opportunities for our business moving forward and our ability to execute. We’re pleased with our year-to-date 2018 performance and we believe we’re well positioned to deliver our tenth straight year of snack and POS growth in the U.S. As a result, we expect to deliver fiscal ’18 net sales consistent with our previously stated long-term growth algorithm of 4 to 6%. Regarding adjusted EBITDA, with the tax benefit reinvestment and the previously communicated incremental $2 million of public company expenses, we now anticipate adjusted EBITDA growth rate of slightly less than net sales. We appreciate everyone’s interest in The Simply Good Foods Company, and with that Todd and I are available to take your questions. Operator?

[Operator:]

[Operator instructions] Our first question is from Jason English with Goldman Sachs. Please proceed.

[Jason English:]

Hey, good morning folks. Thank you for letting me ask a question. I’ve got a couple of questions, but I’ll try to keep it tight to leave room for others. First, you mentioned strong velocity offsetting planned distribution losses in prepared remarks. When we look at the Nielsen data, there is no evidence of distribution losses, at least that we can see on the data, so can you elaborate on the source of these losses? Are they relatively recent, perhaps not showing up in the data so something we should anticipate going forward, or is it possible that they’re happening in non-measured channels?

[Todd Cunfer:]

The biggest discontinue losses, Jason, were--you know, we had Life, a sub-brand called Lift which we discontinued about a year ago, so that’s been a bit of a drag in our retail takeaway for the last year, and some other just normal in and out products that we’ve replaced, so in the data that we see there are some discontinuation losses, but as Joe pointed out, the base velocity gains have more than offset them and we’re really, really pleased with that.

[Jason English:]

That’s helpful, thank you. You mentioned due diligence expenses that you incurred this quarter. Is it fair to assume that they’re in relation to prospective acquisitions and not expenses tied to previous activity; and if so, can you give us a little bit of color of what you’re seeing out there in the marketplace, obviously nothing specific, but as we look across the M&A environment, it looks to be much more of a seller’s market than a buyer’s market given some of the multiples out there. Are you seeing any quality available assets out there at reasonable prices?

[Todd Cunfer:]

Yes, so first of all, the $1.9 million of transaction expenses was a combination of the shelf registration where the secondary offering, where Roark was able to sell their shares, which went well in February, and there was also some M&A expenses. Obviously now we need to incur those expenses as incurred. I obviously can’t speak specifically on particular assets, but we have a very active portfolio. We feel good about the opportunities that are out there. We continue to engage with people, and we feel there is going to be opportunity throughout the year, but we’re going to be smart buyers and we’re only going to purchase things that we feel are good value.

[Jason English:]

Very good, thanks guys. I’ll pass it on.

[Operator:]

Our next question is from Chris Growe with Stifel. Please proceed.

[Chris Growe:]

Hi, thank you. Good morning. I just had a bit of a follow-on to Jason’s question on M&A. There was an outline at least of a potential acquisition in that secondary filing in the proxy - I believe it was the proxy. Do you have any update on that, or can you--will there be further disclosure, maybe perhaps in the 10-Q, that would come out around that?

[Joe Scalzo:]

Yes, we really can’t, Chris. We can’t comment on any kind of pipeline in M&A, other than we have a pretty active pipeline at this point, we continue to pursue opportunities where we think we can add value, and if and when we’re able to talk about it, you guys will be the second one to hear about it.

[Todd Cunfer:]

And there is nothing in today’s Q that will give any more color on that.

[Joe Scalzo:]

Yes.

[Chris Growe:]

Okay, that’s good. Thank you. Then just to understand, with the increased investments you’re making, especially those that are related--those investments related to the brand, if you will - marketing, that kind of thing, is that a--is there a desire to try to accelerate revenue growth, or is that an investment required to support 4 to 6% growth going forward? Just curious how you look at that kind of going forward and the benefit that investment could provide.

[Joe Scalzo:]

You know, Chris, it’s hard to parse that apart other than we’re happy right now with what we’re seeing in the investments that we’re making, right? So first and foremost, what I would tell you is we feel like we have ideas and areas that are worthy of investment, so the tax reform benefit gave us a little bit extra flexibility to lean in on those things that we know have a pretty good return, so we’re making those investments. It’s hard--you know, from our perspective, it’s hard to really parse apart is it late 2018, 2019, is it going to accelerate our past the 4 to 6? That’s difficult in this category, so we’re going--where we see the opportunity to make the investments and we have the wherewithal to do it, we’re going to do it, so we saw this opportunity.

[Chris Growe:]

Okay, and just one little follow-on to that, then. As you--you’ve talked about some distribution declines that have occurred across the business, and they were planned. Is--should we expect distribution increases to occur as you’re investing more heavily, as velocities remain very strong? I mean, some one-time things to get around, but it would seem like that should start to pick up a little bit, maybe not radically, but just curious what you see there.

[Joe Scalzo:]

Yes, so the interesting thing in this category is the bifurcation of retailers’ resets, so we see pretty evenly split between spring and fall - about half reset their shelves in the spring, half reset their shelves in the fall, so we--so it takes about a year from the time we decide to launch something to really get it into--you know, be able to present it and let customers make decisions in 100% of ACV. So you know, if you’re losing items, that takes kind of a year to play out; as you’re gaining items, again it takes about a year to pay out. We like our product innovation that we talked about today. We think it’s interesting and compelling. We’ll start to see, I think, some impacts of that on shelf resets in the spring, and then fully as we close out the calendar year and move into next calendar year.

[Chris Growe:]

Okay, thank you very much.

[Joe Scalzo:]

Yes, you’re welcome. Have a good day.

[Operator:]

Our next question is from Rob Dickerson with Deutsche Bank. Please proceed.

[Rob Dickerson:]

Thank you very much. Good morning.

[Joe Scalzo:]

Good morning, Rob.

[Rob Dickerson:]

First, welcome Mark. Very happy to have you at Simply Protein - just wanted to say that up front. A few questions, all pretty basic. I guess first is just in terms of organic sales for the year. You’re now, I guess, close to 5% in the first half, guide says 4 to 6, you’re right in the midpoint of guidance; but is there anything that we should be aware of Q3 or the back half that could cause potential acceleration or deceleration? Thanks.

[Todd Cunfer:]

Yes, so the only thing I really want to point out is obviously we benefited from the acquisition in our numbers in the first half. That will go away in the second half, so it’s all going to be core growth, so everything else being equal, it will be down just because of not having that Wellness Foods benefit. But you know, we’re still in that 4 to 6% range, feel really good about recent POS growth. As Joe pointed out, it’s hard to project this category because it’s pretty volatile, but we’re feeling--you know, at this point we’re feeling very good about where we are in the second half.

[Rob Dickerson:]

Okay, great. Then just in terms of the Lowe effect, so to speak, just initial results - you know, better than expected, kind of in line, good enough to extend a contract potentially? Just any thoughts you have as to how that’s progressing, thanks.

[Joe Scalzo:]

Yes, great question. The Lowe effect is high. We feel really good about what he’s done for our business, I think as we mentioned in our remarks - presently surprised by kind of the key leading indicators of his impact, his ability to appeal to both groups of buyers, his ability to generate PR, website is an early indicator, and probably the best and most favorable indicator is our buyer growth is up. So this is a category, to remind everyone, that is still relatively under-penetrated, it’s under 50%, so there’s a lot of headroom to bring people to the category and to our brand, and that is something we pay attention to very closely, increasing penetration. The early indicators, January, February and March, are he accelerated buyer growth, which is very important to us, so exceeded our expectations and we’re very encouraged, and one of the reasons that we’re leaning in our marketing investment.

[Rob Dickerson:]

Okay, yes. That was kind of my point, because obviously your organic sales growth did well in the quarter but you’re also tapping into that self-directed consumer more because you’re bringing new buyers into the category and the brand, partially probably driven by packaging, but the commercials look pretty good too. Is that kind of a fair summary?

[Joe Scalzo:]

Well said, yes.

[Rob Dickerson:]

All right, and then advertising for the year, I think before it was up 7, the expectation is that given the bit of a reinvestment, is that number up to 8 or 9?

[Todd Cunfer:]

It’ll be slightly higher than we’ve talked about previously, yes.

[Rob Dickerson:]

Okay, and then I may have missed this, is just Simply Protein, I saw some of the innovation at Expo West, looked, tasted great. What is the specific timing such that that would be on shelf?

[Todd Cunfer:]

More to come on it. We’re close. If things go well, we’ll have some news at the next conference call. We expect something to happen before calendar year 2018 on Simply Protein.

[Rob Dickerson:]

Okay, great. Then lastly, ecommerce growth, did you mention that in prepared remarks? If not, could you?

[Todd Cunfer:]

Did not. Year-to-date, we are about--on shipments, we’re about up 75%.

[Rob Dickerson:]

Lovely. All right, thank you.

[Joe Scalzo:]

That’s a round number.

[Rob Dickerson:]

Perfect.

[Todd Cunfer:]

Thank you.

[Operator:]

As a reminder, if you would like to ask a question, it is star, one on your telephone keypad. Our next question is from Bill Chappell with SunTrust Robinson Humphrey. Please proceed.

[Grant O’Brien:]

Hi, this is actually Grant on for Bill. I guess our first question was just on the timeline for the packaging update, reformulation, kind of where are we in that process, and how much more time do we have to go there?

[Joe Scalzo:]

Yes, this is Joe. Packaging is 75% on the shelf today. When you refresh packaging, it’s typically a run behind, so you’re working through old inventory, moving in new inventory, new packaging, so faster velocity retailers, faster velocity SKUs transition quicker, slower velocity retailers, slower SKUs slower. So you know, it’ll be--key SKUs in our big retail stores have already changed. It’ll be through the spring and probably early summer before everything else is current on the shelf. From a reform standpoint, I think we mentioned in our comments most of our meal bars have been reformed and about half of our snack bars have reformed to date, and the challenge there, why take so long, is that we’ve got to reform, test product against current, and make sure that we have at least parity liking, if not preference on the reform, so if we don’t get to that, we go back to the drawing board until we do. We feel good about it. I think we mentioned in our comments that where we’re seeing the new reforms on the shelf, velocity of those items are accelerating.

[Grant O’Brien:]

I got it. I guess--so kind of following up on that, is there any way to parse out the impact from those reforms versus maybe the marketing spend, Rob Lowe impact?

[Joe Scalzo:]

I wish I could do that for you. I cannot.

[Grant O’Brien:]

Okay, and then actually just our last question here, we’ve been hearing a lot on freight costs increasing, maybe. What’s your outlook here for the rest of the year?

[Todd Cunfer:]

We’ve had--as I mentioned, we have had some impact on higher freight and distribution costs, probably not to the magnitude you’re seeing from others. The good news from our standpoint is we have some projects in place that have enabled us to mitigate some of the inflation and cost pressures we’ve seen on distribution. We’re doing some direct ships from some of our [indiscernible] to major customers’ warehouses, that’s been a bit of a benefit for us. So yes, we’re seeing pressure, I’m sure we’ll continue to see some pressure on that in the second half, but fortunately to date the inflation we have seen has not been dramatic.

[Grant O’Brien:]

Great, thanks so much.

[Operator:]

Ladies and gentlemen, we have reached the end of the question and answer session. I would like to turn the call back over to Mr. Scalzo for closing remarks.

[Joe Scalzo:]

Thanks again for your participation on today’s call. We look forward to updating you on our third quarter results in July. We hope everyone has a good day.

[Operator:]

Thank you. This concludes today’s conference. You may disconnect your lines at this time, and thank you for your participation.